A brief recap – ESAs’ January 2021 letter to the EU Commission, EU Commission response and adoption of RTS

Signed by the European Parliament and the Council of the European Union on 27 November 2019 and published in the Official Journal of the European Union on 9 December 2019, the Sustainable Finance Disclosure Regulation (SFDR)1 impacts both firms and products and requires three types of disclosure – pre-contractual disclosure, website disclosure and periodic reporting. On 7 January 2021 – less than eight weeks before the SFDR ‘go live’ date – the Chair of the Joint Committee of the European Supervisory Authorities (ESAs)2 wrote to the European Commission (EU Commission) highlighting that the ESAs had encountered several important areas of uncertainty in the interpretation of SFDR and that there are “certain priority questions pertaining to the SFDR that would benefit from a more urgent clarification to facilitate an orderly application of SFDR from 10 March 2021.3 The questions raised by the ESAs encompassed many of the questions that market participants were grappling with as they tried to prepare for 10 March 2021. To access our OnPoint on the ESAs' questions, please click here. On 26 July 2021, the EU Commission published its long-awaited Q&A4, which attempted to respond to the ESAs’ specific questions. Unfortunately, rather than providing the desired clarity, in many areas, the EU Commission merely repeated the ESAs’ questions or cited sections of SFDR Level 1 text, without adding any clarity on important matters pertaining to the interpretation of SFDR and to a certain degree adding to the confusion regarding the implementation of the SFDR. The EU Commission’s response is addressed in our OnPoint, available here.

On 6 April 2022, the EU Commission announced that it had adopted the regulatory technical standards (RTS) to be used by Financial Market Participants (FMPs)5 when disclosing sustainability-related information under SFDR. The RTS are currently under scrutiny by the European Parliament and Council of the EU and the expectation is that they will apply from 1 January 2023. For more information, please see our OnPoint “EU Commission adopts RTS under the SFDR”, available here. However, just days after adopting the RTS, the EU Commission mandated the ESAs to review and propose amendments to those RTS.

More queries on SFDR

On 13 May 2022, the ESAs submitted ten further, relatively technical, queries6 to the EU Commission relating to the interpretation of EU law with reference to SFDR and the Taxonomy Regulation7. The questions are divided into the following categories:

  • Principal adverse impact (PAI) disclosures – The ESAs ask, where FMPs are below the threshold set by Article 4(3) and Article 4(4) of SFDR and choose not to consider adverse impacts of investment decisions on sustainability factors at entity level, are those FMPs able to consider PAI at product level for certain financial products (per Article 7 of SFDR)? If those FMPs do consider PAI at product level, can they disclose this under Article 4(1)(b) of SFDR.
  • Financial advisers – The ESAs ask a number of questions across a variety of aspects of SFDR – including financial advisers’ obligations when giving MiFID advice; what information advisers need to collect and from whom; and whether there are certain circumstances where a financial adviser might not be obliged to comply with Articles 3, 4, 5, 6 and 13 of SFDR.
  • Transparency of the integration of sustainability risks and rules for products no longer made available – The ESAs ask whether the obligations under Article 6 and Article 7 of SFDR apply:
    • To new products only or whether those obligations also apply to financial products that were already in existence on 10 March 2021 (SFDR date of application), even if those financial products were no longer made available to investors.
    • To existing portfolio management financial products.

    Where financial products are no longer made available to new investors, the ESAs ask if:

    • The pre-contractual disclosures under Articles 6 and 7 of SFDR need to be updated and delivered to existing investors.
    • The website and periodic disclosures under Articles 7, 10 and 11 of SFDR need to be provided to investors.
  • Good governance practices – the ESAs query whether, where a financial product disclosing under Article 8 or 9 of SFDR does not invest in companies with good governance, that financial product should be able to continue disclosing under Article 8, 9 and 11 of SFDR.The ESAs also ask if a financial product investing solely in government bonds while applying an ESG investment strategy can be considered to fall under either Article 8 or Article 9 of SFDR. The basis for the question is that the requirements of Article 8 relate to “companies”8 and Article 9 specifically refers to “investee companies” by reference to the definition of “sustainable investment” under Article 2(17) of SFDR9, which would not seem to relate to governments.
  • Scope of Article 5 and 6 of the Taxonomy Regulation – the ESAs ask, if an Article 8 financial product does not commit in the precontractual disclosures to invest in any “sustainable investments” per Article 2(17) of SFDR, is the FMP obliged to disclose the information set out in Article 6 of the Taxonomy Regulation? And what are the FMP’s disclosure obligations if it is later determined that the financial product has in fact invested in “sustainable investments”? The ESAs ask a similar question in relation to Article 9 financial products – if the Article 9 financial product only committed in its precontractual disclosures to invest in sustainable investments with a social objective (social objectives currently being outside the scope of the Taxonomy Regulation), but the FMP subsequently determines that the financial product in fact invested in economic activities contributing to an environmental objective, would the FMP be obliged to disclose the information required by Article 5 of the Taxonomy Regulation?

Conclusion

The EU Commission has not yet responded to the ESAs’ queries, but the fact that there are still important questions needing to be answered over a year after the SFDR go-live date and four months after the Taxonomy Regulation go-live date, indicates the complexity of the two Regulations. This further highlights the significant challenges FMPs are facing as they try to comply with their obligations.

RTS – more changes afoot?

Just two days after the EU Commission’s 6 April 2022 announcement that it had adopted the RTS, the EU Commission gave a clear signal that the RTS were still not necessarily in final form. On 8 and 11 April 2022, the EU Commission sent two letters to the ESAs asking them to propose amendments to the RTS as currently drafted. The letters were published on ESMA’s website on 6 May 2022.

Mandate to the ESAs to develop RTS on product exposures to gas and nuclear activities

In its 8 April 2022 letter10, the EU Commission refers to its adoption on 9 March 2022 of the Complementary Climate Delegated Regulation11 and states that it considers it necessary to make amendments to the RTS to “ensure that investors receive information reflecting the provisions set out in the Complementary Climate Delegated Regulation”. The EU Commission’s concern is that if it is does not adopt such amendments, several areas in the RTS “might risk, if not adjusted, not to appropriately reflect the new factual and regulatory situation”.

Accordingly, the EU Commission has asked the ESAs to propose amendments in relation to the information that should be provided in pre-contractual documents, on websites and in periodic reports about financial products’ exposure to investments in fossil gas and nuclear energy activities, in particular on the proportion such investments represent within all investments and in environmentally sustainable economic activities, reflecting the provisions set out in the Complementary Climate Delegated Regulation.

In terms of timing, the EU Commission requests that the ESAs submit the amendments to the RTS at the latest by 30 September 2022.

In its 11 April 2022 letter12, the EU Commission recognises that “developments in a novel and fast evolving area like sustainable finance disclosures will require regular adaptions of the regulatory technical standards to reflect increased demand for high quality sustainability-related information and to further promote supervisory convergence”. Consequently, the EU Commission has mandated the ESAs to look to amend the provisions in the RTS relating to (i) principal adverse impacts (PAI) indicators and (ii) transparency by financial products.

In respect of the mandate to propose amendments to the PAI indicators, the EU Commission states that “technical issues” have emerged since the SFDR was originally agreed, which concern the sustainability PAI indicators referred to in Article 4(6)13 and (7)14 of SFDR. The ESAs are invited “to (1) streamline and further develop the regulatory framework, (2) consider extending the lists of universal indicators for PAI, as well as other indicators, and (3) refine the content of all the indicators for adverse impacts and their respective definitions, applicable methodologies, metrics and presentation”. The EU Commission states that a guiding principle for the ESAs’ amendments to the RTS should be “to reduce the risk of ‘false certainty’ and potential ‘safeguards washing’ by requiring well substantiated evidence that investments align with the safeguards, and that implementation and application efforts do take place”.

The ESAs are also requested to propose amendments to the RTS in relation to financial product transparency, in particular in relation to decarbonisation targets provided in financial products’ pre-contractual documents, on websites, and in periodic reports and actions pursued. Furthermore, the EU Commission states that the ESAs should consider whether the provisions in the RTS regarding financial products referred to in Articles 5 and 6 of the Taxonomy Regulation sufficiently address the disclosure and information on environmentally sustainable economic activities (i.e. taxonomy-aligned activities).

In terms of timing, the EU Commission requests that the ESAs provide their proposed amendments “at the earliest opportunity” and at the latest within a period of 12 months following the receipt of the mandate letter.

Conclusion

The ESAs’ mandates from the EU Commission were not expected at this phase in the process. While the mandate to amend the RTS in relation to gas and nuclear activities is unlikely to cause FMPs a significant amount of disruption, the same cannot be said of the mandate to propose amendments in respect of PAI indicators.

FMPs are already facing challenges to comply with the provisions of the April 2022 RTS which are expected to go-live on 1 January 2023 for a reporting period covering the 2022 financial year. FMPs are investing considerable time, effort and resources to ensure they have systems and controls in place before 1 January 2023, and having to amend these systems – possibly significantly – in the near future in order to add additional PAI indicators or change the calculation methodology is unlikely to be seen as a welcome development.